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I’ve written about this topic a few times in the past, such as in this article on tax diversification of your investment accounts.  It’s an important topic, but probably the most important subtopic has to do with having a significant portion of your investments not only in tax-deferred accounts, like 401(k) or IRA, but also in regularly-taxed accounts.  Roth-type accounts are also critically important, but given the limited availability and costly nature of getting assets into a Roth-type account, I’ll focus for now on the importance of the taxable investment account.

With a taxable investment account, you have the opportunity to use the tax code to your advantage, even though it may seem counter to your initial thoughts on the topic.

Granted, in a taxable investment account you don’t get the complete tax-deferral that is available from an IRA or the tax-avoidance in a Roth IRA.  So with that fact, you know that you won’t get to deduct your investments from your taxable income – but at the same time, when you take distributions from the account, any growth that occurred will be taxable.

But the taxability isn’t the same with a taxable account versus your IRA.  For example, if you invested $10,000 in a taxable account and it grew to $15,000, you would owe tax only on the growth, $5,000.  In addition, the tax rate being used is the capital gains rate, which currently tops out at 15%, for total tax on the distribution of $750.  The net result for your account is a withdrawal worth $14,250.

On the other hand, if you invested $10,000 in an IRA you’d receive a tax deduction for the contributions (over a couple of years, due to limitations), which might amount to $2,500 if you’re in the 25% bracket.  After the growth of $5,000 occurred, you are now able to take distribution of the $15,000 – which is now fully taxed at your 25% rate. The total tax is $3,750 – and now your net result for this account works out to $13,750.  This is your total IRA account ($15,0000), minus the ordinary income tax ($3,750), plus the tax deduction credit from your original contributions ($2,500).

A Different Outcome

So the taxable account actually is better in the long run.  And it actually could get even better, depending upon the circumstances of how the $5,000 growth occurred.  Let’s say that the investments were in two different asset classes, for example international stock and domestic stock.  Over the years, these two asset classes experienced some rather wild swings in returns, for example let’s say that the international stock experienced returns of 15%, -10%, 20%, 20%, 15%, 10%, and 20%.  The domestic stock (for the purposes of our example) had returns of -10%, 5%, -15%, -5%, 10%, -5%, and -7.5%.

If each year when there were offsetting losses and gains in each of the asset classes you used the capital gain and loss rules to your advantage, you’d owe tax only on the difference of taxable gain.  Here’s how it works out:

So, as you can see, you wind up with the same net investment account balance, but by netting your gains and losses annually you wind up paying $35 less in taxes.  It should be noted that the Year 2 tax impact includes using the excess loss of $350 against ordinary income, which results in an even larger tax reduction since ordinary income is taxed at 25% in our example.

This example is simplified to illustrate the affect.  The true benefit occurs as this plays out over many years.  The tax benefit of $35 from the example works out to a 4.6% reduction in the tax over just 7 years.  Even if you don’t work the gains/losses rules in your favor – perhaps all of your investments increase in value so you have no losses to utilize – the difference between the taxable account’s tax impact and the IRA’s impact is significant enough to make the case.  Use a taxable account – the results can be a windfall to you!

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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By the time you turn 40, your attention is likely to gain more focus on the amount of savings that you have. If you haven’t already gained control of your spending and saving habits, now is the time to do so. 40 is also an age when you’re probably beginning to think about future retirement or sending the kids off to college. What amount of savings should you have put back by then, and how will you ever be able to accomplish your goal? The truth is, there are no restrictions to the amount of money that you can save if you put your creativity and knowledge to good use.

What Are You Saving For?

Building a hefty savings account is only made more difficult if you do not have a clear idea of exactly what it is that you are saving for. Saving money just to save it can be effective, but it is still important to set a clear goal for yourself. If you know what you are saving for, deciding between a $5 latte and that trip to Italy is made a lot easier. Do you want to be able to travel after the kids leave for college? Do you want to retire early? What about college tuition for your children? All of these are important questions to ask yourself when building a savings account.

Start Saving Early for the Best Payoff

Did you know that if you start saving just $50 per week at the age of 30, you will have more than $40 thousand dollars by the time you are 40 years old? Starting early on savings can have a huge payoff in the end. Ultimately, the longer you are able to save for your goal, the less you have to save each week or month.

Earn Savings by Freelancing Your Skills and Talents

Freelancing your skills on the side can be an excellent source of revenue for your savings. Offering guitar or beading lessons, tutoring and even landscaping on the weekends are all ways that you could earn money towards your savings goal. Trying to save can be difficult if you’re on a tight budget, but there are always new ways to make money.

Maintaining a clear focus on your goals and getting creative with your ideas (rather than letting your savings account overwhelm you) is by far among the best foundations for building a strong savings at 40, or at any age.

This article was written by Kelly Austin from HigherSalary.com. Visit her site for information about the average accountant salary and pay information for other popular careers.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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Planning your retirement can be a daunting task. If you are pretty new to the work force, your life at old age may not seem like a pressing issue. You have at least twenty years until you want to quit your job for good. Why worry now? However, unless you would like to work well into your 70′s, planning your retirement as early as possible should be a top priority. The comfortable living and traveling we associate with retirement isn’t guaranteed for everyone. If you and your spouse don’t discuss options from now, you may be struggling when old age hits. Don’t forget to consider the medical bills, college tuition, and extra expenses you will accumulate at a later age.  Make a spread sheet of your retirement funds in addition to your spouse’s. Figure out how much money you would be able to withdraw on a yearly basis.

So if you want to get the worm, or in this case, that exotic vacation to Bali with your wife/husband, be an early bird and get your funding options in order! Some different types of plans to consider are listed and described below.

Types of IRAs and Employer Sponsored Plans

An IRA is an individual retirement account, which provides savings and tax benefits to account holders before and after retirement. In addition to holding the account, tax payers often set up an annuity, which is a contract you sign with a life insurance company. The company will pay either a lump sum payment during the time of retirement, or regular payments to their client. Other plans are employer-sponsored, which are based on employee salaries and employer options.

Traditional IRA: This type of account is tax-deferred. To be eligible to hold this account, you must have sufficient income to regularly contribute to the account. Your transactions not subject to tax until withdrawal, and this includes all interest, capital gains, and dividends in the account. Once you do withdraw the funds, they will be subject to federal income tax. You may also be penalized if you take the funds out before age 59½. The main advantage of this account is your contributions are tax deductible.

Roth IRA: This type of retirement account can contain your investments in securities, stocks, bonds, and mutual funds. The account can also consist of an annuity contract, which you sign with a life insurance company. The main advantage of this type of account is its flexibility. You can take out your contributions at any time. The disadvantage of this type of account is it is not tax deductible.

Defined Benefit Plan: This is an employer sponsored plan, which enables employees to be paid regular payments for a set number of years or months post retirement. The amount of money employees receive is usually based on a formula, based on salary history and years of employment. Over time, this is a more favorable plan, but employers are increasingly choosing to offer defined contribution plans.

Defined Contribution Plan:  This employer-sponsored plan is becoming increasingly popular, although it does involve risk for employees. Employers or employees put a certain amount of money as contribution every month for this plan. The money is invested in mutual funds or company stocks. Thus the amount of money available at the employee’s time of retirement depends on the success of the company stocks. Some types of defined contribution plans are listed below.

• 401 K: This is the most popular employer sponsored plan, in which employers match employee contributions to this plan. However, you are not eligible to withdraw the funds until retirement.
• Profit Sharing: This is a really great plan, if employers offer it to their employees. The employer makes all the contributions to the employees’ retirement     plan, but this is based on the profit made by the company that year.

By-line:

This guest contribution was submitted by Jamie Davis, who specializes in writing about masters degree. Questions and comments can be sent to: davis.jamie17@gmail.com.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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Social Security taxation: Especially if you had unusual income taxed in 2010, such as a Roth Conversion, you could be subject to as much as 85% taxation of your Social Security benefit.

Alternative Minimum Tax: If you’ve been impacted by this, not only are your ordinary income tax items taxed at a higher rate, but your capital gains and dividends could be taxed at a rate higher than 15% as well.  This happens for folks with incomes between $150,000 and $439,800 (or $112,500 and $302,300 for singles) as the AMT exemption phaseout occurs.

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Child Tax Credit: If your income is over $110,000 ($75,000 if filing Single), the Child Tax Credit reduces by $50 for each $1,000 over that limit.  This has the effect of increasing the marginal tax rate by 5% for each child, as your income increases.

Passive Loss phaseout for rental realty: If your AGI is greater than $100,000, the deduction of up to $25,000 of losses from rental real estate is phased out up to an AGI of $150,000 when the deduction is eliminated altogether.  This can increase the marginal tax rate by 50% ($25,000 credit eliminated as your income increases by $50,000).

There may be other reasons that impact your tax bill, but these are some that have recently come to light as typically occurring.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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Even though the majority of the discussion and analysis that Koppel brings forth deals with professional traders, the behavioral psychology applies to individual, non-professional investors as well.

An example of a particularly interesting passage is one where Koppel quotes Nassim Taleb from his book, The Black Swan - effective responses to Black Swan Events (such as the 2008 economic crisis or the 9/11 crisis):

• What is fragile should break early, while it is still small. Nothing should ever become too big to fail.
• There should be no socialization of losses and privatization of gains.
• People who were driving a school bus blindfolded (and crashed it) should never be given a new bus.
• Do not let someone making and “incentive” bonus manage a nuclear plant – or your financial risks.
• Counterbalance complexity with simplicity.
• Do not give children sticks of dynamite, even if they come with a warning.
• Only Ponzi schemes should depend on confidence.  Governments should never need to “restore confidence”.
• Do not give an addict more drugs if he has withdrawal pains.
• Citizens should not depend on financial assets or fallible “expert” advice for their retirement.
• Make an omelet with the broken eggs.

The above list should give you some insight into this book.  It’s not your typical, conventional viewpoints on the activity of investing – buying and selling stocks, bonds, mutual funds and the like. Koppel takes what he knows from his own personal experience (former member of the Chicago Mercantile Exchange, hedge fund partner, and president of his own division at Rand Financial) as well as discussions with dozens of other folks in the industry, and applies recent psychological findings to it.

Through this application of psychological findings it becomes clear that there is a specific set of skills that leads to success in investing.  Koppel infers that this set of skills is learnable – once you discover and assuage the negative patterns of thought and action that lead to failure.  Much the same as a master sommelier’s ability to discern a wine’s source grape from a mere whiff and a slurp, the professional investors who have learned these skills are often capable of “pulling the trigger” on a purchase or sale of a financial asset in the face of compelling psychological factors that would urge a man to choose otherwise.

Some of these factors include: having a goal for your investing activity; having a plan for both getting into and getting out of every position; understanding your own irrational thought processes and developing a framework for overcoming them; and using your most powerful investing tool – your intuition.

Koppel explains these factors and skills in terms not only of investing, but of sports, love, gambling, and many other facets of life – since the folks who have developed the skill set apply the skills to many areas.  It just so happens that some of these successful folks are also investors for a living.

Although I doubt if reading this particular book will remedy all psychological ills that the investor faces, it does help, in my opinion, to begin to put a face on the things that we do to ourselves that work against our success in investing.

The above book review is part of a series of reviews that I am doing in an arrangement with McGraw-Hill Professional Publishing, where MH sends me books with the only requirement being that I read the book and write a review – like it or not.  If you find the information in this review useful, let me (and McGraw-Hill) know!

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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When you have the bulk of your financial assets in retirement plans, you might accidentally expose yourself to some risks that you haven’t thought about… since retirement plan assets are much more likely to be impacted by changes to legislation – as we have seen in the past.

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In these days when Congress is looking for money just about everywhere, it’s not a stretch to imagine new legislation coming down the pike to tax retirement plan assets (like the 15% “excess” plan accumulations that was enacted in 1986 and later repealed).  Other possibilities include accelerating required minimum distributions to achieve a faster payout taxation of the plan; eliminate the “stretch” provisions; or even nationalization (yikes!) as suggested to Congress by experts as recently as 2008.

Assets held outside of retirement plans enjoy capital gains tax treatment (under current law) that is generally much more favorable than the ordinary income tax rate. Plus, these assets also can receive a step-up in basis when passed to your heirs, removing the capital gains on a lifetime’s appreciation in the account, whereas retirement plan assets do not receive this treatment.

This is not to say that you want to eliminate your retirement plans altogether, but rather to balance your assets by tax treatment.  It makes good sense to diversify by tax treatment, as a hedge against the various things that could occur to the retirement accounts.

There is no perfect formula for determining what is the appropriate amount to maintain in tax-deferred retirement plan accounts versus taxable versus Roth accounts – this is determined by the individual, along with his or her trusted advisors.

Sometimes it makes sense for the individual to have the lion’s share of his or her savings in deferred accounts, such as when we’re very young.  At other stages in life (early retirement before age 70½, for example) it could make a lot of sense to start eliminating the deferred accounts in favor of Roth or taxable accounts.

The idea is to weigh the tax impacts of moving money about against the potentialities that are out there for massive changes to the tax treatment rules on those accounts.

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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Recharacterization is the “backing out” of your Roth conversion.  In other words, you can literally make the conversion as if it had never been done at all, with your money back in the traditional IRA where it started.

Why would you want to do that?  Here’s an example: let’s say you converted $100,000 to a Roth IRA in 2010 and you are ready to pay the tax on your 2010 return (you elected out of the spread to 2011 and 2012).  Except that now, your investment in the Roth IRA has dropped in value to only $50,000 – and you still owe tax on the conversion of $100,000!  Yikes – that’s just totally wrong!

Recharacterization can help to save you in this situation.  As long as you act before the due date of your return (including extensions), you can put recharacterization to work for you, moving the $50,000 back to the traditional IRA.  It will be as if nothing was done at all, and no taxes are owed.

Actually, as far as the IRS is concerned you are not moving $50,000 back, you’re moving the original $100,000 and the gains or losses on that original $100,000, which happens to equal $50,000.

Recharacterization Strategy

One way to use this to your advantage is to split your Roth conversions up into separate accounts by specific types of assets, so that if one of the asset types (or more) happens to drop significantly in value, you can recharacterize the conversion on only that account, leaving the other account(s) intact.

This would help with your record-keeping, since any amount that you recharacterize from a Roth to a traditional IRA must include the gains or losses that are attributable to the recharacterized amount.  Of course, you wouldn’t likely recharacterize unless you had net losses in the Roth account – although you might find that recharacterization is a good option if you came up short of cash to pay the tax on the original conversion.

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You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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Of course, any investment that you make in a tax-deferred fashion is a good one, at least in theory.  But there are other investments that make the most sense for your IRA versus other vehicles… and some investments that make more sense in other kinds of investment accounts, where possible.

Listed below are a couple of considerations to take into account when considering taxation of your IRA and non-IRA investments.

Bonds and other interest-bearing vehicles

Given the nature of the IRA – deferring taxation on current income and growth, investments that would otherwise be taxed at ordinary income tax rates would be best for your IRA.

This includes the likes of interest-bearing investments, such as CDs or bonds.  Since, presumably, your tax rate when you begin taking distributions will be either the same or less than your rate before retirement, the deferral will provide for the interest to be taxed at either the same rate or lower, just later in your life.

Growth-oriented and dividend-paying investments

Growth-oriented stocks and investments that pay current dividends make more sense to be held in taxable accounts than in deferred accounts.  This is due to the fact that dividends and capital gains are (at least for now) taxed at much lower rates than ordinary income – which is the rate your distributions from the IRA will be taxed at.

The same would be true of other growth- and dividend-oriented investments such as real estate and commodities, for example.

Bottom Line

So in other words, if you have the ability, you should split your interest earning investments into your IRA, and growth- and dividend-oriented investments into taxable accounts.  This way, you won’t be subjecting lower-taxed items to a higher tax rate – if possible.

This doesn’t mean that you should ONLY invest in items that would be taxed at ordinary rates within your IRA.  This is known as letting the tax-tail wag the investment dog.  Tax planning should always be considered as you plan your investments, but appropriate diversification should always be your first consideration.

In addition, the deductibility of IRA (and 401(k)) contributions provides a benefit that should be weighed against the taxation concepts we’ve talked about above as well.  Again, the tax-tail shouldn’t wag the investment dog…

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You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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The passage relates to how we view investments in general, as well as the importance of having a goal for your investments and saving activities.  Keep in mind that passage was written more than 40 years ago, so some references will be woefully out of date, but the message is still clear and valid.  Let me know if it gives you inspiration – I thought it was particularly good:

A stock is, for all practical purposes, a piece of paper that sits in a bank vault.  Most likely you will never see it.  It may or may not have an Intrinsic Value; what it is worth on any given day depends on the confluence of buyers and sellers that day.  The most important thing to realize is simplistic: The stock doesn’t know you own it. All those marvelous things, or those terrible things, that you feel about a stock, or a list of stocks, or an amount of money represented by a list of stocks, all of those things are unreciprocated by the stock or the group of stocks.  You can be in love if you want to, but that piece of paper doesn’t love you, and unreciprocated love can turn into masochism, narcissism, or, even worse, market losses and unreciprocated hate.

It may sound a little silly to have a reminder saying The Stock Doesn’t Know You Own It were it not for all the identity fuel provided by the market these days.  You could almost sell these identities as buttons:  I Am the Owner of IBM, My Stocks Are Up 80 Percent; Flying Tiger Has Been So Good to Me I love It; You All Laughed When I Bought Solitron and Look at Me Now.

Then there is a great big master button called I Am a Millionaire, or I Am So Shrewd My Portfolio Has Gone into Seven Figures.  The magic of this million-dollar number, and of its accessibility to Everyman, is so great that books sell with titles like How I Made A Million or You Can Make Millions, with very little content at all.  They are the most dangerous of all the things written on the market because (and I collect them as a hobby) inevitably there is some mechanical formula somewhere within.  Never mind who you are or what your capacities and abilities are, just charge in with the book open to chapter three.

If you know that the stock doesn’t know you own it, you are ahead of the game.  You are ahead because you can change your mind and your actions without regard to what you did or thought yesterday; you can, as Mister Johnson said, start out with no preconceived notions.  Every day is a new day, providing, in the Game, a new set of continuously measurable options.  You can live up to all those old market saws, you can cut your losses and let your profits run, and it doesn’t even make your scar tissue itch because, being selfless, you are unscarred.

It has been my fate to know people who have made considerable amounts of money, sometimes millions, in the market.  One is Harry, who made it and blew it and made it again.  Harry really wanted to make a million dollars, and he did.  I think Mr. Linheart Stearns had a very good point when he said the end object of investment ought to be serenity.  Now if you think making a million dollars will give you serenity, there are two things you can do.  One is to find a good head doctor and see if you can discover why you think a million dollars will give you this serenity.  This will involve lying on a couch, remembering dreams, talking about your mother, and paying forty dollars an hour.  If your course is successful, you will realize that you do not want a million dollars but something else which the million dollars represents to you, such as love, potency, mother, or what have you.  Released, you can go off about your business and not worry any more, and you will be poorer only by the number of hours you spent in accomplishing this times forty dollars.

The other thing you can do is to go ahead and make the million dollars and be serene.  Then you will have both a million dollars and serenity, and you do not have to deduct the number of hours times forty dollars unless you feel guilty about making it.

It seems simple, and there is indeed a catch.  What do you do if the million dollars arrives and serenity does not?  Aha, you say, you will worry about that when you get to it, you are shure you can handle it.  Perhaps you can.  Money, contrary to popular myth, does help people more than it spoils them, simply because it opens up more options.  The danger is that when you have your million, you then want two, because you have a button saying I Am A Millionaire and that is who you are, and there are, all of a sudden – as you will notice – so many people with buttons saying I Am a Double Millionaire.

<portion eliminated>

The trouble with Harry is not just the trouble with one man who made and lost a lot of money, nor even that there are hatching, at this very instant, other Harrys who will play out this role next month and next year.  The trouble goes beyond Harry, beyond Wall Street; it’s a kind of virus in the whole country, when the cards of identity say not how well the shoe is cobbled or the song is sung, but are a set of numbers from an adding machine.  Usually we hear only the triumphs by adding machine, but those who live by numbers can also perish by them, and it is a terrible thing to have an adding machine write an epitaph, either way.  Perhaps measuring men by the marketplace is one of the penalties of our age, but if some scholar would tell us why this must be, we would all know more about ourselves.

Boilt down, the gist of this passage is two lessons:

1) Don’t get emotionally involved in your stock, fund, or whatever investment you make.  All decisions should be made without regard to your past ownership or any other factors besides the fundamental and technical analysis you do on your investment choices.

2) Have a goal in mind for your investment activity.  What “Smith” recommends is simply serenity – and if you can define “serenity” for yourself, you’ve set the goal.  And if serenity isn’t what you’re looking for, choose and define “chaos” or whatever is important to you.

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Excerpt from The Money Game, by ‘Adam Smith’, pages 81-84

You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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The rule is relatively clear, but what’s not clear to many folks is that this applies to all accounts that you and your spouse own – including IRAs.  How can capital losses be considered within IRAs, you may ask?

Well, here’s an example:  Say you purchased 100 shares of ABC stock in your taxable account at $50 per share several years ago.  After holding the shares for quite a while and watching them languish and continue to lose value, you decide to sell the shares at $40 so that you can at least take the tax loss for some minimal benefit from the situation.

Then, a week after you sell the shares, you learn that ABC is ready to introduce a brand-new, absolutely revolutionary, widget.  This new widget is expected to blow the industry away – and you want to get in on the action.  So, realizing that you just sold 100 shares for a loss, you have your spouse buy 100 shares in his IRA for $43, 8 days after you sold the original 100 shares.

Bingo.  You just triggered the wash sale rule, disallowing the original loss for tax purposes.  This is because in considering the wash sale, all accounts, IRA or not, for you and your spouse, are included.  Unfortunately in this case your tax loss is gone forever since your IRA purchase has no tax basis.

Had the accounts been reversed – that is, if the original purchase had been made in the IRA and the subsequent purchase made in the taxable account, you’d at least have your basis of $43 against which future capital gains or losses would be calculated.  Additionally, if you had only waited 30 days from the original sale of the shares of ABC, you could have made the purchase in either account with no wash sale impact.

So be careful as you make tax loss moves – consider all of the ramifications of the wash sale rules.

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You can pick up my book, A Social Security Owner's Manual, at Amazon in either the print version or the Kindle version by clicking the links.
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